Trust me: how a constructive trust saved millions

10 December 2019

The recent decision of the Court of Appeal (CA) in Alice Kahrmann (as administrator of the estate of Rainer Christuab Kahrmann) v Hilary Harrison-Morgan (2019) may on the face of it appear to be a textbook dispute between a daughter and step-mother but it teaches us more than meets the eye, particularly in respect of the power of a constructive trust.

The CA ultimately held that a daughter (as administrator of her father’s estate) was entitled to recover £2.2 million from the proceeds of sale of two properties, which had been paid to her step-mother following her father’s death. The properties were found to be held on an express common intention constructive trust for the estate.  The step-mother has been ordered not only to account for the £2.2 million paid to her but also interest and legal costs.

What is a constructive trust?

In brief, a constructive trust is a trust which arises by operation of law where it would be unconscionable for a person who holds an asset to deny that another person has a beneficial interest in that asset. For example, a constructive trust may arise where:

  1. A person holds funds that he/she knows have been paid to him/her by mistake; 
  2. A person holds an asset that he/she has obtained by means of fraud;
  3. Two people share a common intention that a person should have a beneficial interest in an asset and that person has acted to his/her detriment on the basis of that intention. This is known as ‘common intention constructive trust’.

Background

Dr Kahrmann was a German businessman who died suddenly without a valid will. At the time of his death he was domiciled in Germany but he had two valuable properties in Belgravia, London. Dr Kahrmann had two daughters from his first marriage, but later commenced a relationship with Hilary after his wife passed. Dr Kahrmann and Hilary had two sons together, however never married and eventually separated after 10 years together. Dr Kahrmann moved to Germany and Hilary stayed in the flat in the larger of the two properties.

Prior to Dr Kahrmann’s death he was entitled to purchase the freeholds of the properties due to his substantial long leasehold interests. This is called collective enfranchisement, i.e. where leaseholders in a building can join together and buy the freehold. Dr Kahrmann assigned his interests in the properties to his business partner in return for half of the profit from their sale after the freeholds had been acquired. After his death, a profit of £8.8 million was realised upon the sale. Pursuant to a sale agreement, the business partner received half of the profit and half was split between the two daughters (£2.2 million) and Hilary (£2.2 million). However the daughters thereafter commenced proceedings to recover the £2.2 million from Hilary.   

The CA found that Hilary was not entitled to receive the £2.2 million. The CA specifically held that:

  • there was an express and inferred agreed common intention that the benefit of the collective enfranchisement be held in equal shares between Dr Kahrmann and his business partner. Dr Kahrmann had acted to his detriment in reliance on the express and inferred agreed common intention by e.g. assigning his beneficial interests and leaving his business partner to arrange the onward sale of the properties.  
  • The £2.2 million paid to Hilary formed a traceable part of the proceeds of sale which Dr Kahrmann’s estate was entitled to. Dr Kahrmann’s equitable proprietary interest in the contract to acquire the freeholds could be traced into the freehold properties when they had vested. Alternatively, an express constructive trust of the freehold arose upon its acquisition and could be traced into the £16 million purchase price.
  • The two arguments advanced by Hilary to try to defeat the estate’s claim were rejected, namely:
  1. that Hilary was a bona-fide purchaser without notice of the estate’s claim

The CA held that a reasonable person in Hilary’s position would have had serious cause to question the propriety of the proposed payment to her. She had attended meetings and received documents which put her on inquiry, but she failed to make such inquiries as would have been reasonable in the circumstances to confirm that Dr Kahrmann’s estate did not have a proprietary right to the £2.2 million.

  1. that there was a separate enforceable agreement to give up vacant possession in return for £2.2 million

The CA found it necessary to consider what rights of occupation (if any) Hilary might have been able to assert if she had refused to give up vacant possession. As Dr Kahrmann was domiciled in Germany, Hilary had no claim for reasonable financial provision under the Inheritance (Provision for Family and Dependants) Act 1975 and any claim by her children under the Children Act 1989 would have required her to show that the flats were property which Dr Kahrmann was entitled to, which directly contradicted her pleaded case that his only entitlement was to a share of the proceeds of sale. 

Comment

This is an important decision as it confirms that constructive trusts of a traditional kind can arise in a commercial context where there is an express agreement. Case law has differentiated between disputes in the domestic context i.e. former cohabitees about their beneficial interests in property they have occupied as their family home and disputes in the commercial context e.g. where property is jointly purchased as an investment. It has been established that principles developed in a domestic context should not normally be applied to cases in a commercial context. However the CA in this case focused on the strength of an express agreement (between Dr Kahrmann and his business partner) in order to infer an understanding between them such that contractual rights to enfranchisement were capable of being held on constructive trust.  The finding of a constructive trust was vital in order to facilitate equitable tracing. 

Whilst it may appear to some that the result is unjust in denying Hilary any entitlement to the estate after a 10 year relationship, two children and having given up vacant possession of the property, it is a stark reminder of the very real risks unmarried couples continue to face,  which we have previously written about here.

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